Good morning, everyone, and welcome to the Citizens Financial Group first quarter 2018 earnings conference call. My name is Kevin. I'll be your operator today. Currently, all participants are in a listen-only mode. Following the presentation, we will conduct a brief question and answer session. As a reminder, this event is being recorded. I'll turn the call over to Ellen Taylor, Head of Investor Relations. Ellen, you may begin.
Thanks so much, Kevin, and good morning, everybody. We really appreciate you joining us today. We're going to start things off with prepared remarks from our Chairman and CEO, Bruce Van Saun, and CFO, John Woods, who will review our first quarter results. Then we'll open up the call for questions. We're really happy to have in the room with us today, Brad Connor, Head of Consumer Banking, and Don McCree, Head of Commercial Banking. In addition to our release, we have a presentation and financial supplement available at investor.citizensbank.com. I need to remind you that our comments today will include forward-looking statements, which are absolutely subject to risks and uncertainties. We provide information about the factors that may cause our results to differ materially from expectations in our SEC filings, including the Form 8-K we filed today.
We also need to remind you that we utilize non-GAAP financial measures and provide information and a reconciliation of those measures to GAAP in our SEC filings and our earnings release materials. With that, I'll hand it over to Bruce.
Okay, thanks, Ellen. Good morning, everyone, and thanks for joining our call today. We're pleased to report that we're off to a good start to 2018. We continue to deliver good top-line growth. We had 5.6% year-on-year revenue growth. We're also doing a nice job of managing expenses. This resulted in positive operating leverage of 2.1%. Our ROTCE improved to 11.7% as we chart our course towards our new medium-term targets of 13%-15%. We achieved year-on-year average loan and deposit growth of 3%. In the first quarter, we saw linked quarter spot and average loan growth of around 1%. Based on our pipelines, we feel this will pick up as the year progresses. Similarly, based on strong capital markets pipelines and the benefit of seasonality, we expect to see some good fee growth in the second quarter.
We continue to execute well on our strategic initiatives, building out our customer coverage and our product capabilities while making critical investments in technology, in our digital platform and data capabilities, as well as in our customer experience initiatives. We continue to find new ways to streamline our processes and organization in order to become more efficient and to self-fund these investments. Our projects TOP and BSO are delivering consistent results. As you may suspect, we are working hard on the development of TOP V. Stay tuned for our July call and for more details. We continue to make progress in building excellence in our capabilities. We're now gaining some external recognition for our progress. For example, we were named the number one bank in the U.S. in terms of customer experience by Temkin.
We also were ranked the best bank by Global Finance Magazine in the Northeast and in the Great Lakes regions. There's certainly more work to do, but we're making good progress and we're poised for a strong 2018. We have a good plan. We have a good leadership team that's executing well across the board, and we have an engaged and motivated colleague base. With that, let me turn it over to our CFO, John Woods, who will take you through the numbers in more detail and provide you with some color. John?
Thanks, Bruce, good morning, everyone. Let's get started with our first quarter results on page four. We continue to execute well and are off to a good start to the year. We generated net income to common shareholders of $381 million, diluted EPS of $0.78, and ROTCE of 11.7%. Last year's first quarter and fourth quarter reported results are impacted by notable items, largely related to tax matters. To make it easier to see underlying trends, let's turn to page five, we will focus on our underlying results that exclude these items. Year-over-year growth in Q1 was very strong as we grew net income to common shareholders by 31% and EPS by 37%. This reflects our continued focus on driving positive operating leverage, which came in above 2% along with favorable credit costs and a lower tax rate due to tax reform.
Strong net interest income and a continued focus on expense discipline helped deliver an efficiency ratio improvement of 125 basis points to 60.4%. We also see the impact of our disciplined risk management on our credit quality metrics as we continue to drive improvement in the mix of the portfolio overall. Provision expense came in at $78 million for the quarter, which was a little lower than expected, despite an $8 million build in the reserve. Non-performing loans remain relatively stable at 78 basis points of loans. We continue to actively manage our capital base, returning $283 million of capital to shareholders through higher dividends and share repurchases. Tangible book value per share increased 5% year-over-year to $27.24, and our CET1 ratio was a robust 11.2%.
Taking a deeper look into NII and NIM on page six, we delivered attractive and disciplined balance sheet growth, which helped drive a 1% linked quarter increase in NII in spite of the impact from day count. We benefited from the earlier than anticipated move in one-month LIBOR this quarter and a relatively steeper yield curve overall for much of the quarter. As a reminder, approximately 75% of our sensitivity is associated with the short end of the curve. Linked quarter net interest margin increased eight basis points, reflecting improving earning asset yields given higher rates and improved mix, which drove a 16 basis point improvement. This was partially offset by an eight basis point impact from higher funding costs. Year-over-year net interest margin improved 20 basis points, reflecting a 42 basis point benefit from earning assets, partially offset by a 22 basis point impact from funding costs.
Our margin performance continues to benefit from our balance sheet optimization efforts, which again drove about one-third of our year-over-year NIM improvement. We also continue to be well-positioned to capitalize on the rising rate environment with our asset sensitivity relatively stable at 5%. Turning to fees on page seven. On an underlying basis, non-interest income decreased 4% linked quarter, reflecting an expected seasonal decline in service charges, as well as a reduction in mortgage banking fees and trust and investment services fees, largely related to the impact of long-term rates on product demand. In mortgage, our originations were down about 19%, in line with overall industry headwinds given rates and a shift away from refi volume. We're making investments to grow our MSR portfolio and to shift production towards more conforming volume.
In wealth, investments in the business are helping to drive improvement in the mix of our fee-based sales, which came in at 42% this quarter. However, we saw a reduction in transaction fees from strong fourth quarter levels, which was paced by strength in fixed rate annuity sales. Capital markets fees declined modestly from fourth quarter and first quarter as there was a market falloff in middle market syndicated transactions. As a partial offset, we did see a pickup in debt and equity capital markets activity, which benefited underwriting fees. Our capital markets pipelines look very robust heading into the second quarter, including several deals that were originally targeted for the first quarter. Overall, the pipelines have improved significantly since the start of the year. Turning to expenses on page eight. On an underlying basis, expenses were up 3% linked quarter, reflecting seasonally higher salaries and employee benefits.
Outside services were seasonally lower, and other operating expenses reflect lower insurance and pension costs. Year-over-year, our expenses were up 3% on an underlying basis as salaries and benefits expense was higher, reflecting annual merit increases, increased stock-based compensation costs, revenue-based incentives, and the impact of strategic growth initiatives. We also saw an increase in outside services costs tied to our consumer strategic growth initiatives. We continue to remain disciplined on the expense front as we identify opportunities to streamline our operations and organization to find efficiencies. This allows us to self-fund our growth initiatives and enhance our capabilities to serve customers. Let's move on and discuss the balance sheet. On page nine, you can see we continue to grow our balance sheet while expanding our NIM. Total average and spot loans were up 1% on linked quarter basis and 3% year-over-year, with core loan growth rates slightly higher.
We grew the average core retail portfolio 5% year-over-year, with expansion in residential mortgages and higher risk-adjusted return categories like education, which is largely tied to our refinance product, as well as nice traction in other unsecured retail loans driven by our merchant financing partnerships and our personal unsecured product. This growth was partially offset by planned reductions in the auto portfolio and runoff in home equity, given high levels of payoffs in line with industry trends. On a spot basis, core retail loans were up 4% year-over-year and relatively stable linked quarter given the auto and home equity trends. Average core commercial portfolio growth of 2% year-over-year reflects strong momentum from our geographic expansion strategies, private equity, industry verticals, and commercial real estate. On a spot basis, the commercial core loan growth came in at 3% year-over-year and 2% linked quarter.
Growth was impacted by the sale of about $190 million of commercial loans late in the first quarter as part of a strategy to source, underwrite, and distribute leverage loans, as well as some softer results in small business lending. We expect to deliver stronger loan growth in the second quarter. This reflects the strong Q1 spot growth in commercial banking and overall strength in their lending pipelines, which are up over 35% from the beginning of the year through mid-April. In retail, we expect particular strength in education finance given higher seasonal volume and our continued investments in the space, as well as the renewal of our flow agreement with SoFi for high FICO score loans.
On page 10, looking at the funding side, we saw a 6.5 basis point sequential quarter increase in our cost of deposits, reflecting the impact of higher rates and spot deposit growth of 1%, partially offset by progress on our initiatives to control deposit costs. We continue to fund attractive balance sheet growth at accretive risk-adjusted returns. Our overall funding costs were up nine basis points sequentially. Year-over-year, our cost of funds was up 25 basis points, reflecting deposit cost increases of 20 basis points, as well as a structural shift to more long-term borrowings, including our $750 million senior debt issuance near the end of the first quarter. Year-on-year spot and average deposit growth was 3%. Note that while funding costs were up 25 basis points, overall asset yield expansion was 43 basis points.
Our deposit betas remain in line with our overall expectations given where we are in the rate cycle. We did see our betas tick up a little, which is what you would expect to see in a quarter following a Fed hike, we are right on our expected glide path. Our cumulative beta on interest-bearing deposits is in the mid-20s. We've seen some increased competition for deposits, but for the most part, deposit costs have been well-behaved. We are continuing to invest in analytics and improve our targeting through digital and direct mail offerings on the consumer side, we're continuing to migrate away from our historical approach to promotional pricing. In commercial, we are making investments to build out additional product capabilities and roll out our new cash management platform early next year.
We feel good about our ability to execute against our optimization strategies and drive greater efficiency in deposit gathering. Next, let's move to page 11 and cover credit. Overall credit quality remains strong, reflecting the ongoing mix shift towards high quality, lower risk retail loans and a relatively clean position in the commercial book. The non-performing loan ratio improved slightly to 78 basis points of loans linked quarter, while improving 19 basis points year-over-year. The net charge-off rate improved to 26 basis points from 28 basis points in the fourth quarter, given seasonal impacts. Our commercial charge-offs were very low again this quarter, and retail net charge-offs were $3 million lower than the fourth quarter, primarily due to seasonality in auto and education. Provision for credit losses of $78 million was $8 million above charge-offs.
Despite this reserve build, the provision was down $5 million compared to the fourth quarter, and down $18 million versus a year ago, reflecting improvement in overall credit quality. On page 12, you can see that we continue to maintain robust capital and liquidity positions. We ended the quarter with a CET1 ratio of 11.2%. This quarter, we repurchased 3.9 million shares and, including dividends, returned $283 million to common shareholders. On page 13, we have provided color on how we are progressing against our strategic initiatives. We've changed the slide a little in order to highlight some of the progress we are making against our efforts to optimize the balance sheet, investments in our fee-generating capabilities, and our TOP program revenue and efficiency initiatives. We also wanted to highlight some interesting things that are going on in the businesses.
Overall, we are executing well and our TOP IV program, which is on track to deliver $95 million-$110 million of pre-tax run rate benefit by the end of 2018. The TOP programs have successfully delivered efficiencies that have allowed us to self-fund investments to improve our platforms and product offerings while achieving profitability goals. We are already looking at opportunities to find further efficiencies in the future by expanding the work we are doing around customer journeys, lean process improvements, and agile ways of working to more areas of the bank. I can tell you that we are constantly challenging ourselves to do better, and we have plenty of wood left to chop in the efficiency area. Let's turn to our second quarter outlook on page 14. We expect average loan growth to come in at about 1.5%, and we expect NIM to be up modestly in the quarter.
In non-interest income, we are expecting to see a mid-single digit pickup from seasonally lower first quarter levels. We expect to keep expenses broadly stable in the second quarter, with positive operating leverage and with efficiency improving. We expect the credit environment to continue to be relatively benign and that provision expense will push a little higher into the $80 million-$90 million range. On the tax rate, we came in a little lower than expected for the first quarter, given a change in timing on certain tax items that moved to Q2 from Q1. For the second quarter, we are expecting our effective tax rate to come in at about 23%. To sum up on page 15, we feel like we've delivered solid results in Q1. We feel our balance sheet across capital, liquidity, and credit position remains robust.
We will maintain our mindset of continuous improvement in 2018 and look to drive more top-end BSO program benefits. We are also driving innovation across the bank and investing heavily in technology, our digital platform, and customer journeys, which positions us well as we work towards becoming a top-performing bank. We will maintain our mindset of continuous improvement in 2018 and look to drive more top-end BSO program benefits. We are also driving innovation across the bank and investing heavily in technology, our digital platform, and customer journeys. Lastly, we are positive about our outlook for the second quarter and the rest of the year, and we reiterate broad full-year 2018 guidance. Although we expect we'd be better than the guidance range on credit. With that, let me turn it back to Bruce.
Okay. Thanks, John. Kevin, I think we can open it up for Q&A now.
Thank you, Mr. Van Saun. We are now ready for the Q&A portion of the call. If you wish to ask a question, please press star then one on your touchtone phone. You will hear a tone indicating that you are in queue. You may remove yourself from queue at any time by pressing the pound key. Once again, for questions, please press star then one. The first question comes from the line of Matt O'Connor, Deutsche Bank. Your line is now open.
Good morning.
Hey.
Yeah, I was just wondering if you could talk a bit more about the fee revenues. We're seeing it from other banks as well, but just kind of some softness across a number of categories. You were pretty clear about capital markets pipeline being strong and bouncing nicely in 2Q. Just some of the other categories were also a little bit soft and wondering what that says about just the underlying activity among the customer base and maybe why that is the case.
Sure. Why don't I start, and then we can pass it around here for color. Matt, I would say probably the disappointments in Q1, really capital markets where we saw, I'd say, a number of transactions push from Q1 to Q2. We, I think had seasonal slowness at the start of the year. Things seemed to pick up nicely in March, although, as I said, didn't get everything done. That bodes well for, I'd say, a quite positive outlook in Q2 in capital markets. The other area that I'd call out is the mortgage business, where I think there was just general market softness. There's a shift away from refis as rates has gone up. It was just a tougher quarter than we expected in the mortgage space. Most of the other lines, I would say, were really just impacted by seasonality.
We get an extra day in Q2. We get some seasonal benefits. Service charges and fees is always up. There's things that we anticipate when we give the guidance for Q2 that we have pretty good visibility into. John, I don't know if you want to add to that.
No, I think that's right. I think you're seeing as we get to the end of the quarter, we mentioned that pipeline's looking much better in capital markets as we get into the second quarter. A little bit of seasonality in the IRP space. As you mentioned, in mortgage, although it was a down quarter, we're seeing some improvement in our conforming mix, that'll bode well going forward as well.
Yep. Okay.
That's helpful. Separately, if we look at the deposits, the non-interest-bearing demand deposits continue to grow year-over-year. Obviously, there's some seasonality linked-quarter, you're still growing those year-over-year. Some of the bigger banks are seeing outflows, and I'm just wondering if you could talk about maybe how your mix is a little bit different, or do you think it's more granular in terms of why you're still able to grow the free deposits in this higher rate environment?
John, why don't you start, Brad offer some color.
Yeah, I think that's right. We did see that we've been investing a lot in this over the last couple of years, as you know. On the deposit, I think this is a reflection of our deposit initiative starting to take hold. On the consumer side, we're seeing some traction where we've been investing in data and analytics. We've been improving our targeting and promotional efficiency, that's starting to play itself out. We've revised our promotional approach to attract more stable deposits at attractive rates. The emphasis is basically shifting from rate-led to more of a moderating on rate and starting to close the gap a little bit on marketing. We've been extending the duration and targeting direct mail in lieu of mass promos. That's nice to see on the consumer side.
Similar themes on the commercial side, where we've been making ongoing investments in our product offerings and targeting certain segments where deposits are more likely to be able to be driven versus others. Yeah, we're pleased to see that improvement and those investments will continue.
Yeah, John, I think you hit it. I think the big thing for us has been the improvement in analytics and targeted offerings. The other area that you didn't touch on is, and we've signaled this for several quarters in a row now, is our focus on our massive affluent customer base and redesigning the value proposition and the product set for that. We relaunched a whole new value proposition, our Platinum product suite, I guess, about a year ago. We just think we're getting good traction from that and the investment in analytics.
Some of the interest fees are coming with that initiative.
Exactly.
Yep.
Exactly.
Okay. Thank you.
All right. Your next question comes from the line of Ken Zerbe, Morgan Stanley. Your line is open.
Great. Thank you. If we do get any SIFI reform, you guys will-
Hey, Ken.
Ken, we're having a little trouble hearing you, Ken.
Yeah, you're on a bad line. Ken, you're on a bad line.
Is this better?
A little bit.
A little bit.
Okay. Sorry. Hopefully, this will be clear.
That's good now. Now you're good.
Okay. If we do get SIFI reform, you guys are no longer subject to CCAR. Can you just talk about how you think about accelerating capital return? Has your thinking changed at all over the last several months or quarters?
I'd say we're probably more optimistic that we can maybe move down our glide path a little faster overall. Generally, I think we've been measured in terms of bringing the capital down, I think as a relatively new public company with not a very long track record that that's a sensible approach. We're thinking 40 basis points, maybe 50 basis points this year was the target we set out at the beginning of the year. As you know, last year, we stayed at 11.2. We were trying to get down to the 10.7-10.9 range. Because we overshot and did better than our budget, and we also had the benefit of tax reform on our DTL, we ended up with earnings that we couldn't return to shareholders given the way CCAR works.
One of the things that we're actually excited about is the de-designation, then also the new proposal for the stress capital buffer which I think gives more flexibility back into the hands of the banks. You have guardrails about where you need to operate, you also, if you have situations like we had where you're outperforming and making extra income, you can potentially return that to shareholder as you're in the middle of the year, as opposed to waiting for the next cycle which is a real benefit. If you were anticipating you were going to get 6% loan growth and it turns in to be 4%, you can do something with that extra capital that's piling up. Anyway, I'd say in general, we feel more positive. I think we'll continue to be measured, and we'll just bring this down.
As I said in the past, there's no reason that we need to be above the median of our peers. Our stress credit losses are actually slightly below the median. Over time, I think we can certainly glide it right into where the median of our peers are.
All right, great. Separately, with your NIM guidance, can you just help reconcile the 5% asset sensitivity that you guys mentioned versus the guidance that NIM should be up only modestly in second quarter, given the recent March rate hike? What are the pluses and minuses there that would limit the NIM expansion? Thanks.
Yeah. I'll go ahead and take that. Thanks. You know what, I think you should know that as we mentioned the NIM performance in the first quarter, we did have an earlier one-month LIBOR benefit. That was up maybe about nine basis points on average. By March, one-month LIBOR was 20 basis points higher than we had expected at the beginning of the quarter. We're not planning on that recurring. That would be one item that I would highlight in terms of the second quarter. Also, we mentioned that there was a big increase in the long end in the first quarter, which had an impact on our premium amortization in our securities book which was slowed down as a result of that movement. You wouldn't necessarily plan on seeing that happening again in the second quarter.
Lastly, I'd highlight the fact that the full quarter mix shift in our funding where we did a senior unsecured issuance at the end of the first quarter, and you'll see the full quarter effect of that in the second quarter. Those are some of the takes, but nevertheless, even with all of that, we're still expecting that NIM will expand, and that's given by our ongoing asset sensitivity, driven by the fact that loan yields are expected to be up again and up very nicely with good solid loan beta offsetting our deposit beta in the second quarter.
Great. That's very helpful. Thank you.
Your next question comes from the line of Peter Winter, Wedbush Securities. Your line is now open.
Good morning. I was curious about the guidance for net interest income for the full year. Last quarter, you said it was 7% to 9%. It does seem like the margin is coming in better than what you expected for the full year, and you're getting that rebound in loan growth. I'm just wondering if you could talk about the guidance for the full year on net interest income.
What I would say, Peter, is we're just broadly saying that we hold to what we said. I think you could go down each of the major income categories and we haven't been specific on that. Given trends, certainly net interest income is pushing out to the upper side of the bound with the NIM performance. I still think that we'll see a decent level of loan growth over the course of the year. When you go down, I still think we can hit the range for fee growth, and expense growth is tracking to be in the range. The one thing that John called out is that I think given the first quarter result and the guide for second quarter on credit, that we're likely to be certainly below the range we set on credit.
That's a little more color for you, where we really try to focus our comments on these quarterly calls is the upcoming quarter and not get into reforecasting explicitly that full year guidance. We're certainly comfortable with the numbers we put out there for the full year back in January.
Okay. Thanks. Just to follow up, is there any update you can give on your Apple partnership and also if just the personal unsecured lending and how that's going?
I'll just start I'd say that our view is that we have a very strong relationship with Apple that's centered around our shared focus on customer experience. We would continue to see growth in the relationship. Then secondly, on the personal unsecured product, we really launched that with a vengeance maybe 18 months ago, we've had a tremendous take-up. We're using our data analytics capability to target not only our customers but also prospective customers, we're bringing new customers into the bank, I think that's going exceptionally well. I'll turn it over to Brad for additional color.
Yeah. Not sure I have a lot more to add, Bruce. On the Apple front, we have a great relationship with Apple, and we stay focused on giving them great service, and we think we do that, and it's a good relationship. On Pearl, we're very pleased with the product. It's performing credit-wise the way we expected. Good demand for the product. We have stayed in the prime plus space. We've stayed at the very high end of the market. I think there's opportunity to go in the credit spectrum there, but at this point, we're staying focused on our niche, sticking to our knitting and staying in the really high credit quality area and feel very good about it.
Thank you.
Okay.
Your next question is from the line of Erika Najarian, Bank of America. Your line is now open.
Hi. Good morning. Thank you very much. Just following up on Ken's questions, could you give us a sense of on your variable rate loans on the asset side, if you could give us a sense of what the short-term benchmarks are and on the liability side, if your long-term debt is swapped out, and if so, what the underlying benchmark would be? Thank you.
Sure. I'll jump in on that one. Basically, on the floating rate side of things, you have a couple of key benchmarks. In the C&I book, it's primarily one-month LIBOR, although we do have a few billion dollars of three-month LIBOR indexed on the commercial side. Generally, it's a one-month LIBOR book. When you think about the other big floating books, you've got the home equity portfolio, which is essentially a prime-based, Fed funds-based book. That's on the asset side. On the liability side, we do have primarily a floating rate book there. What we swap that to is actually one-month LIBOR and three-month LIBOR as well. There's a mix there with, frankly, the majority of that actually going to one-month LIBOR.
When you think about what's contractual with respect to three-month LIBOR on the asset side and three-month LIBOR on the liability side, we've been monitoring that because of what's been going on with three-month and one-month LIBOR over the quarter. We're pretty balanced, at least contractually, with respect to the asset side and the liability side of the three-month point on the curve. Let me know if that's responsive to what you were looking for.
No, that was very clear. A follow-up question is, of course, we'll hear more about TOP V in July. Given how successful these initiatives have been, I'm wondering if you could give us a sense on how much of TOP V will be revenue-driven rather than expense-driven.
Sure. I'll start, John. You can add color. I think each year, what we try to focus on is an effort around efficiency and extracting inefficiencies to streamline how we're running the bank. We'd like that to make up, I'd say, at least 40% of the pot to whatever total number we get to. We also have always great ideas in terms of how we can serve our customers better and deliver additional products and services or expand into some new adjacencies as we've done, for example, geographically into the Southeast region on the commercial side. I think there's opportunity there as well.
I'd say what we find heartening here is that we're able to come back and do this year in and year out, which I think sets us apart really from peer banks who might have a major program maybe every three years or so. We've tried to instill this into our culture and our DNA at Citizens that it's our responsibility to come up with these ideas about how we're going to run the bank better and do more for our customers and do more for our shareholders. John, maybe you could add some additional thoughts.
Yeah. Just maybe a bigger picture when you think about our targets for ROTCE progression over the medium term that we talked about last quarter. We built in that there would be on the expense side something on the order of 60 basis points over that period of increasing our ROTCE. If you triangulate that back to our expense base, that comes in somewhere between 1% and 2% of our expense base in savings each year coming out of TOP. That's been an incredibly important part of how we're driving expense save. We'll continue to do that.
Thank you. That was clear. Appreciate it.
Okay.
Your next question comes from the line of Saul Martinez, UBS. Your line is open.
Hi, good morning.
Hi.
On asset quality, the 425-475, keeping that obviously implies a pretty big ramp up, and you mentioned that there's a high probability of being below that range. Why not just change the guidance? Maybe more importantly, just as you look across the different parts of your portfolio, obviously credit has been remarkably good, but are there any areas that either you're concerned about or that you're watching a little bit more closely as being a little bit more vulnerable to a normalization in credit?
I guess to my earlier answer, we don't want to be in the habit of updating our full year guidance quarter in and quarter out, which is why we're using the broadly comfortable. I think the beat on credit is materially enough outside of that initial range that I think we needed to call that out. That's the answer to the first part of your question. On the second part of your question, I'd say certainly on the consumer side, there's nothing in terms of delinquencies or roll rates that gives us pause. I think we're going to have a very good, clean year on consumer credit. Again, on the commercial side, we have a net recovery position, which is pretty fantastic.
Again, when you look at what we have in NPLs, what we have in criticized assets, we're in very good shape there as well. You're likely over time to take a hit here or there. Maybe you have a recovery that allows you to offset it on the commercial side, but we could see that migrate up a little bit over the course of the year. Specific portfolios, they all look in pretty good shape. Energy, certainly in great shape. We're keeping our eye in the franchise world on some of the casual dining segment, but that's relatively modest, and I think that'll behave okay. Anyway, I'd say those would be the areas I would highlight. John, anything you'd want to add?
Just to add to the point on the consumer delinquencies, even the 30- to 90-day delinquencies quarter-over-quarter, year-over-year are down. We're just seeing good trends there and wholesale credit quality hanging in there very nicely with net recoveries. That's really the story.
I think I agree with that on the wholesale side. The things we're struggling with are generally idiosyncratic and not that large.
Yeah.
We feel very good about where we are.
Good.
That's helpful. Just on deposit competition, you mentioned deposit pricing, you mentioned cumulative betas around, I think, mid-20s, can you just give a little bit more granularity across the different businesses, retail, commercial, wealth, where you're at, what's the dynamic and also where you feel betas are maybe relative to where terminal beta could be for each of those segments?
Yeah. I'll tell you what. We'll talk about the terminal betas maybe top of the house. We haven't necessarily gotten into where it would be across each individual segment, but in terms of within consumer, you'll see terminal betas that are lower than commercial, of course. Overall, we've mentioned that through the cycle, we would be at approximately 60% cumulative beta over the entire tightening cycle, which we tend to think about at approximately a 300 basis points or so Fed funds number. When you break that down, as I mentioned, consumer on the lower end, commercial on the higher end. Within consumer, we are breaking that down a little bit further. When you look at the core consumer in the retail space, as well as even when you get up into mass affluent, we're seeing betas being pretty well behaved in the low single-digit range.
It's when you get into the wealth sectors that things start to get a bit higher and those betas get up into the high 20s and the low 30s. Overall, still very solid single-digit betas cumulatively through the first quarter in the consumer side. On the commercial side, you'll see cumulative betas that are maybe a bit higher than that, maybe up into the 30s or so. That gives us the overall cumulative beta in the mid-20s. Let me see if that's responsive and if there's any follow-ups.
No, that's helpful. If I think about the 60% cumulative beta, obviously, commercial is going to be above that and all the retails are-
Yeah
segments are
Yeah. Commercial is 70-75, let's call it, cumulative, in apples to apples relates to that 60. For consumer, maybe 35-40, to give you something to anchor to with respect to the 60.
Got it. Thanks a lot. That's helpful.
Good.
Your next question comes from the line of Vivek Juneja, JPMorgan. Your line is open.
Thanks. Bruce, a question for you. I had a question on the capital return overall, but just wanted to talk to you about dividend payout.
Yeah.
Where do you see that going? I know you've had good increases, obviously you're still well below peers and recognizing, yes, you're still relatively in your infancy after the IPO. What are you thinking since the Fed has now said the 30% line has also been removed and your peers are talking about 40% type, getting to those levels?
Yeah. No, I think we've said that kind of in the medium term, we were targeting to get back up around 40% or so. You saw us make two moves in the last CCAR cycle, very significant increases. One of the challenges we've had is our earnings have grown so quickly that you end up actually lagging where you'd like to be in terms of your payout ratio. Again, as we get more flexibility under the new kind of Fed proposal, potentially we could accelerate as we're growing our earnings. If we are exceeding our estimates we set out at the beginning of the year, potentially we could be more responsive and move that dividend up quicker. Again, I think bank stocks should trade with a healthy yield. We understand that.
I think we currently, with our capital surplus, can have our cake and eat it too. We can continue to have nice loan growth and support the organic needs of the business and certainly return shareholder capital at a good clip. The dividend would be the top of our list in terms of what we want to do for shareholders.
Thanks. Question for Don, since I heard him on the line. Don, any color on sort of what's giving you the confidence that some of the slowdown we saw in capital markets activity in Q1 should start to dissipate soon? What are you seeing that's giving you in terms of timing and that it actually should start to pick up?
I'll repeat what Bruce said, is we started the year with pretty weak pipelines actually. Literally since early February, we've just seen them build and build and build and build. The activity levels on the teams are quite strong right now. We're seeing it flow through already on the fees that we're printing for the quarter. We're confident in both our clients' desire to transact given the environment and the tax rate and general growth that people are seeing. Sponsors are quite active right now. We're seeing it in our pipelines.
I would say also that we would expect to see M&A pick up as the year goes by. We feel it's fortuitous or maybe we were good, but doing the acquisition of Western Reserve last year gave us the capability that we can now really serve those middle market companies that are looking to use acquisitions as part of their growth strategy.
When I say pipelines, I'm talking about M&A also.
Yeah.
I think we're actively adding to our M&A teams because they can't handle the business that they have in-house right now.
Yeah.
It's quite strong.
Great. Thank you.
Your next question comes from the line of Marty Mosby, VSparks. Please go ahead. Your line is open.
Thanks. A very detailed question. We have heard a lot of pressure from the mortgage banking and production side, and some mention of gain on sales. Sometimes that's when rates are moving higher, you kind of aren't repricing fast enough. That just is a kind of a norm that you get a little bit of squeeze temporarily. Is this more pricing or rate related in a sense of maybe gain on sale or margins going down a little bit this quarter?
Yeah, I think that is more a function of as volume comes down with higher rates, the industry is trying to fill up the capacity that you have, the excess capacity you have available, and you see a squeeze on margins. I think it's just a normal market activity as people are trying to fill up the capacity they have.
Got it. Then when we think about your capital ratios have been relatively flat. As you now move into the next phase with more flexibility on returning this capital, do you envision meaningfully bringing that number down? Do you have a target you'd like to get to in the next couple of years?
Yeah. The flexibility actually comes down the road, it's not really here yet in terms of this CCAR cycle. I think we gave guidance for this year that we'd like to bring our capital ratio down towards 10.7, 10.8, if you look at our full-year guidance. We also set out our medium-term targets, which we said we'd like to bring it down to 10 to 10.25 when we set out those targets. You could see us at 11.2, bring it down 40 basis points, then do that again, then continue to chisel it. It may be the case that the median moves lower and that there's opportunities for us to move below that range. That's the kind of flag that we've planted at this point in our planning process.
Yeah, maybe just to add on top of that, I mean, that flexibility point that we're very pleased and supportive of is really an NPR, and we're working our way through that process with the Fed. If all goes as originally indicated, this would be a CCAR 2019 cycle that where the flexibility would come later in 2019 and into 2020. We're supportive of it. Taking away the soft cap on dividends and addressing some of the concerns from the industry around balance sheet growth is all very positive. Lots more questions to be asked in the NPR, the flexibility will come later, as Bruce indicated.
It's positive in the sense that you have so much earnings growth right now with tax benefit and just the organic growth that payout ratios are going to be 19.20% that keeps the momentum into the last 2 years or that next 2 years after we get the pop in earnings, really creating a lot of the give back this year.
Yep.
Thanks.
Okay, thank you. Your next question comes from the line of Gerard Cassidy, RBC Capital Markets. Your line is now open.
Thank you. Good morning, guys. Can you share with us, you had some, as you pointed out, some nice growth in your demand deposit accounts, which some of your peers haven't really seen. When you look at that, could you share what % of your consumer customers have checking accounts where there's no fees associated with them because either they keep a higher balance or there's a special product that they're using that doesn't charge them fees?
Well, to give you a % that don't have fees, I unfortunately don't have that in front of me. I will tell you our core checking product, so our sort of our baseline checking product, is something we call One Deposit, which is you have the ability to waive your monthly service charges just by making a single deposit every month. The majority of those customers do not incur a fee. In terms of an overall %, I don't have that available.
Yeah. Okay. Thank you. Bruce, obviously, as you've pointed out, you're relatively new as a publicly traded company. You have very strong capital. Of course, you've got a glide path to give it back to shareholders. Another angle would be, of course, to do acquisitions. Could you just give us your views on what you see on the merger and landscape for other depositories over the next, let's call it 12-24 months?
Yeah. I think, Gerard, we've been pretty clear that where we're focused in terms of looking for acquisitions would be really in the fee space. It would be adding to our capabilities, as I like to say, getting a little farther down the track faster in areas in the commercial side in capital markets or on the consumer side in wealth or in mortgage MSRs, for example. Those have been the areas that we have interest. We've had dialogue, and I think we'll eventually do some more things this year, much like we did the Western Reserve M&A boutique last year. I think they'll be of probably modest size because we have a lot of organic growth. We want to stay focused on executing our plan, but then supplement that with things that we can easily plug and play.
The other area that I think we're focused has been on the fintech space. We have about a half a dozen relationships currently with various fintech partners and some really great stuff. Our specified digital wealth offering, our business banking loan origination and fulfillment platform that we have with Fundation, just to name a couple. I think our antenna's out, and we probably could add a handful of additional ones also this year. When it comes to straight depositories, that's really not on our shopping list, and you won't see us looking to do that in 2018.
Great. Thank you.
Your next question comes from the line of John Pancari, Evercore. Please go ahead. Your line is open.
Morning.
Hi.
You had mentioned the better loan beta, where you're trending right now. How much of that is the pricing environment? I mean, we're hearing that it's certainly not terribly accommodative right now, and that there's some spread compression a lot of your peers are dealing with. Therefore, how much of that is also just your structure and that you've got a fair amount of portfolios that you're still sub-scale in but are higher yielding and you're growing there, so the remix is helping your loan yield? Thanks.
Yeah. I'll go ahead and hit that. I mean, loan yield's up 14 basis points in the quarter. You think about converting that into a beta, I mean, that's really driven by our floating fixed mix. We're basically about 52% or so, as I recall, the percentage swap-adjusted floating loans versus the approximately 48% on the fixed side. That's the big driver in loan betas. You heard a little bit earlier the indices that we're exposed to. The indices are going to be primarily one-month LIBOR and Fed funds in terms of driving that beta on the loan side. You could think about that beta cumulatively being around 60% or so when you think about a much higher beta on the commercial side, say, call it in the 80s being offset by more of the term lending that sits on the consumer book.
I think that's how you should think about our loan betas on that side.
Okay. All right. Thanks. Actually on that front, the new money loan yields where you're bringing on new production, do you have that for commercial versus consumer?
Yeah. I mean, I would say overall, on the commercial side, new money's coming in, call it 25 basis points or so over runoff money. On the consumer side, basically every book, new money coming in in a healthy way over runoff, with maybe the possible exception of mortgage where you've got the negative or the convex aspects of that kind of portfolio where you see the bias towards refinancing the higher rate stuff. I think that's a natural industry-related phenomenon. Basically across the board, when you run the table across consumer and commercial, we're in a situation where our new front book is accretive versus our runoff, and that's providing upward lift as well and will continue into the second quarter.
That extends, John, to the securities book as well.
Absolutely, yeah. On the security side, our runoff is about 250. Our reinvestment is about 320 on the security side.
Got it. Yeah. Got it. Thank you. That's helpful. One separate thing on the expense side. I know you indicated a couple of times that you continue to invest heavily in IT. Can you remind us of the size of your IT budget? I believe you had previously indicated about $195 million in CapEx. Just wondering what the overall IT budget would be in terms of the non-CapEx amount.
Yeah, John, we went through a period probably from 2010 to 2016, or probably six years there. We had it up around $250 million. We pulled it back a bit last year to the $195 million, as you said. I think we needed to pause and digest some of the things that we'd put in place. This year I'd say we're probably in a $225 million-$235 million ZIP code. The nice thing that I'd say about that is it's really moving and pivoting towards offense. So much of that spend now is directed at how do we serve customers better, how do we digitize, how do we use data? I think there's an unlimited appetite that folks have inside the company. I remind folks, Rome's not built in a day. We have to pace ourselves.
I think we're really spending much more on offense, and the results are showing by you can see the awards we're picking up for customer experience or Best Bank. I think it's really great to see. Maybe just to add to that just briefly. Because of the way accounting works and there's some capital budgets and across peers sometimes it's hard to normalize apples and apples, but some of the industry materials that we've been able to get our hands on would indicate that maybe in the neighborhood of 8% of revenues is about where our peers are coming out. You would see us on an apples-apples basis being around 10% of revenues when you consider our capital expenditures plus some of the things that get expensed and the other support from an IT perspective of the businesses on a customer-facing standpoint.
When you think about it like that, we feel like we're in line or in pace with the industry or maybe a little better.
Got it. All right. Thank you.
Okay.
Your next question comes from the line of Ken Usdin on Jefferies. Your line is open. Your line is open, sir.
Ken? Maybe we lost him.
Ken?
No.
Maybe his question got answered. All right. Okay. Next. Is there anyone else, Kevin?
No, at this time, no further questions in queue. With that, I'll turn things back over to Mr. Van Saun for closing remarks. Please go ahead.
Okay, great. Thanks everyone again for dialing in today. We certainly appreciate your interest and your support. We're off to a really good start. I think we maintain a positive outlook for 2018, and also for another year of strong progress for Citizens Bank. Thanks, and have a good day.
That does conclude today's conference call. Thank you for your participation. You may now disconnect.